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Emerging Market Covenant Quality Scores Improve, But Risk of Cash Leakage Rises

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Tuesday, April 28, 2020 / 5:52 PM / by Moody's Investors Service / Header Image Credit: MSCI

Risk of cash leakage rising amid coronavirus-led downturn and weakening protections
Score remains stronger than non-EM EMEA and North American issued bonds

Moody's Investors Service says in a new report that the covenant quality (CQ) score for emerging markets (EMs) improved slightly in the six months ended 31 March 2020, but that the risk of cash leakage is rising amid the coronavirus-led downturn.

"The average cash leakage score for EM bonds weakened by 4% to 4.06 (weak) in the six months to March 2020, mainly because of repeat Chinese property issuers predating their restricted payments income baskets to coincide with those of their previous bond issuance," says Jake Avayou, a Moody's Vice President and Senior Covenant Officer.

Consequently, half of the 28 full-package Chinese property bonds received the weakest possible cash leakage score of 5.00.

"We did however see a slight overall improvement in the CQ score to 3.25 (moderate) for the six months ended 31 March 2020, from 3.35 (moderate) for the previous six months, as the other five key risk scores either improved or remained the same," adds Avayou.

Liens subordination scores improved the most, strengthening by 10% to 2.57 (good), as a lower proportion of Chinese bonds included credit facility debt carve-outs that can be secured under the permitted liens carve-outs.

The average CQ score remains considerably stronger than for non-EM EMEA and North American bonds issued in the same period in five of the six risk areas that Moody's scores, except structural subordination. Structural subordination remains a key area of weakness because of the lack of guarantees from onshore operating subsidiaries for Chinese bonds, which accounted for 70% of full-package EM bonds during the six months ended 31 March 2020.

Moody's scored 60 EM high-yield bonds during the six months ended 31 March 2020, of which 46 were full-package and 14 were high-yield lite.

Asian companies continued to dominate EM bond issuance, accounting for 80% of issuance, with Chinese companies in turn accounting for 63% of the Asian bonds. Latin America accounted for 13% of EM bond issuance, and Emerging Europe for 7%. There were no bonds from Africa and the Middle East in the six months ended 31 March 2020.

Moody's CQ score combines six factors: (1) cash leakage, (2) risky investments, (3) leveraging, (4) liens subordination, (5) structural subordination and (6) change of control. The average CQ score for EM bonds from January 2011 through March 2020 is 2.93 (moderate).